AHMAD AHMADANI
The National Electric Power Regulatory Authority (NEPRA) has decided to review the returns offered in the power sector and prepared a concept paper for determination of the rate of returns for the power companies.
The official documents available to this scribe disclosed that the NEPRA in a bid to review IRR (Internal Rate of Return) has prepared a concept paper which provided a basis for determining the IRR for various technologies, value chain of power sector i.e. generation, transmission and distribution) and tariff regimes (cost plus, upfront). The IRR now needs to be effectively depicted against specific risk and return matrix and its adjustment for a particular technology, the documents said.
“The concept paper is an attempt to use conventional project finance technique to compute the expected cost of equity to commensurate the investors interested to invest in Pakistan’s power sector,” NEPRA said.
In a public notice, the NEPRA sought written comments from all the stakeholders and interested/affected persons within thirty days to arrive at a just and informed decision.
The documents further said that some issues related to technology specific return, RoE (Return on Equity) under cost plus regime versus upfront regime, RoE review period needed review. “We will use a particular derivative of CAOM called the “Bludgeon Approach” for determining expected return on equity,” The NEPRA proposed in its concept paper prepared to review the returns for the power sector.
The official sources informed that some independent power producers (IPPs) had earned above 35pc returns in power sector, while IRR presently ranges in-between 15 per cent and 20pc. Similarly, under the existing generation tariff regimes of NEPRA, both upfront and cost-plus allow for a fixed Internal Rate of Return needed to be reviewed, they added.
According to NEPRA’s concept paper prepared by its Tariff Division, an IRR to be effective, it has to correspond to the risks associated with generating electricity and at the same time engaging enough to attract the capital needed for a specific technology or purpose (generation or transmission). Also, the IRR must be more tailored towards improving the energy mix and be able to clearly reflect the incentive for investors for a particular technology or resource for improving energy mix.
For Capital Asset Pricing Model (CAPM), the NEPRA proposed to use 5-year US treasury bond rate that any investor can get if he/she invests US dollars in government securities. The interest rate differential between Pakistan risk-free rate and US risk-free rate itself incorporates any impact of depreciation or appreciation of Pakistani rupee (PKR) value against the US dollar.
The NEPRA said although Market Risk Premium (MRP) was the difference between expected return on the portfolio of stock and the risk free rate. However, the number of generation companies listed on the Pakistan Stock Exchange did not offer a reasonable sample size to calculate Beta. Beta reflects the systematic risk/undiversifiable risk. “Beta represents volatility in the value of a stock in comparison to the market. Therefore, for CAPM, unlevered Beta of 0.36 of US utilities will be used,” NEPRA’s paper said.
The NEPRA has also proposed measuring CRP (Country Risk Premium) through market based measures such as CDS (Credit Default Swap) as a better indicator of capturing CRP unlike credit rating.
The authority (NEPRA) proposed that it would reduce IRR for a technology where the risk factors have periodically reduced and later entrants thus do not deserve the same level of IRR as was offered to those who were pioneers in that particular technology. For instance 20pc IRR allowed to Thar coal based power plant should be reduced once a sizeable capacity of plants starts generation electricity using Thar coal. The reason being that early investor in developing Thar coal based power plants have much higher risk because of lack of precedence, NEPRA’s concept paper said.
For transmission & distribution sector, NEPRA said since the market has opened up. Besides NTDC, Fatima group has also obtained special purpose transmission license and international investors have shown interest in entering Pakistan high voltage DC transmission business as a builder and an operator. The authority said the prospective investors need to be provided incentive so that their interest remained focused in the transmission sector.”A reasonable IRR commensurate with the level of risk is the first step in this direction,” the paper said.
Similarly, for RoE review period, the NEPRA said, “We believe 5 year review period is good enough to capture broad risk/return factor for the sector. The CAPM equation can be updated every year only to the extent of the 5 year US bond rate and the prevailing country risk premium in addition to technology specific premium/discount.
